Book Review



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THE LAHORE JOURNAL

OF

ECONOMICS

Lahore School of Economics


Irfan ul Haque

Capital Flows, Trade in Widgets and the Exchange Rate

Pervez Tahir and Sara Fatima

Social and Economic Development -

A Rights Puzzle

Ali Ataullah

Macroeconomic Variables as Common Pervasive Risk Factors and Empirical Content of the Arbitrage Pricing Theory in Pakistan

Aqdas Ali Kazmi

Ricardian Equivalence Hypothesis: Some Empirical Tests for Pakistan Based on Blanchard-Evans Models
Rana Ejaz Ali Khan

Socioeconomic Aspects of

Child Labour-

A Case Study of Children

In Auto Workshops




Arshad Zaman & Asad Zaman

Interest and the Modern Economy


Mohammed Duliem Al-Qahtany

Obstacles Facing Saudi Exporters

of Non-Oil Products

Rukhsana Kalim

Capacity Utilisation in the Large-Scale Manufacturing Sector:

An Empirical Analysis


Note:

Gilbert Etienne


The Economy of Seepage & Leakage in Asia: the most dangerous issue

Book Reviews:

Shamyla Chaudry


A New Institutional Approach to Economic Development

Nina Gera


Transforming Urban Settlements, The Orangi Pilot Project’s Low-Cost Sanitation Model

Volume 6, No.1



Jan-June, 2001


THE LAHORE JOURNAL

OF

ECONOMICS



Editorial Board

Dr. Shahid Amjad Chaudhry - Editor

Mr. Viqar Ahmed - Editor

Ms. Nina Gera - Co-Editor



Editorial Staff: Tele. No: 5874385
Telefax: 0092 - 42 - 5714936
E-mail: les@brain.net.pk

Publisher : Lahore School of Economics, Lahore, Pakistan.
Correspondence relating to subscriptions and changes of

address should be sent to The Lahore Journal of Economics,

105-C-2, Gulberg III, Lahore - 54660 - Pakistan
Instructions to authors can be found at the end of this issue.

No responsibility for the views expressed by authors and

reviewers in The Lahore Journal of Economics

is assumed by the Editor, the Co-Editor and the Publishers.



Copyright by: Lahore School of Economics

62001

THE LAHORE JOURNAL OF ECONOMICS


Contents Vol. 6, 2001




Capital Flows, Trade in Widgets and the Exchange Rate 1

Irfan ul Haque

Social and Economic Development - A Rights Puzzle 19



Pervez Tahir and Sara Fatima

Macroeconomic Variables as Common Pervasive Risk Factors and

Empirical Content of the Arbitrage Pricing Theory in Pakistan 55

Ali Ataullah

Ricardian Equivalence Hypothesis: Some Empirical Tests

for Pakistan Based on Blanchard-Evans Models 75

Aqdas Ali Kazmi

Socioeconomic Aspects of Child Labour-

A Case Study of Children in Auto Workshops 93

Rana Ejaz Ali Khan

Interest and the Modern Economy 113


Arshad Zaman & Asad Zaman

Obstacles Facing Saudi Exporters of Non-Oil Products 129



Mohammed Duliem Al-Qahtany

Capacity Utilisation in the Large-Scale Manufacturing Sector:


An Empirical Analysis 143

Rukhsana Kalim

Note:

The Economy of Seepage and Leakage in Asia:

the most dangerous issue 161

Gilbert Etienne

Book Reviews:

A New Institutional Approach to Economic Development 167


Shamyla Chaudry


Transforming Urban Settlements, The Orangi Pilot

Project’s Low-Cost Sanitation Model 169


Nina Gera


Capital Flows, Trade in Widgets and the Exchange Rate

Irfan ul Haque*


The economics profession has recently started to give increased recognition to the need for restraining capital movements and exercising greater care in opening up capital accounts in developing countries.1 This is a significant development, for, not long ago, unfettered flow of capital across countries was being hailed as a means for improving global efficiency and promoting world welfare. At its annual meetings in 1997, the IMF had pushed to incorporate capital account convertibility into its Articles of Agreement. However, the gravity of the East Asian crisis drove home the dangers inherent in premature deregulation of financial markets and freeing of capital movements, at least as far as developing countries are concerned.

The proponents of caution in the opening up of capital accounts base their case essentially on the imperfections of capital markets or market failures. In the presence of asymmetric information between borrowers and lenders, moral hazard in managing other people’s money, and situations where the risk facing an individual decision-maker is lower than the social risk, a free market is unlikely to yield optimal outcomes. As Bhagwati (1998) has put it, trade in widgets is not the same thing as free movement of capital. The latter suffers from “panics and manias” which can suddenly and quickly more than offset any efficiency gains brought about by the free flow of capital. Bhagwati notes:

“Each time a crisis related to capital inflows hits a country, it typically goes through the wringer. The debt crisis of the 1980s cost South America a decade of growth. The Mexicans, who were vastly overexposed through short-term inflows, were devastated in 1994. The Asian economies of Thailand, Indonesia, and South Korea, all heavily burdened with short-term debt, went into a tailspin … drastically lowering their growth rates.” (p. 8)

This note attempts to extend the case for moving slowly and prudently also to trade liberalisation. It makes basically three points. First, it attempts to show that for both ideological and economic reasons, the opening up of the capital account and the freeing of capital movements are in fact intimately linked to the measures to liberalise trade. Thus, it may be difficult to institute a regime of free trade while the capital account is closely regulated. Indeed, and this is the second point, market imperfections that are put forward as a reason for controlling capital movements and keeping the capital account closed also provide grounds for trade policy interventions. And, third, whether it is trade liberalisation or freeing capital movements, the villain in the piece is the exchange rate management.

The benefits that open trade regimes and free capital mobility promise are more likely to be realised under stable exchange rates, but they also create conditions where exchange rates tend to be unstable. There is evidence that within a liberal trading environment, trade deficits rise, external borrowing is increased, and exchange rates become vulnerable, at least as far as developing countries are concerned. It is typically the fear of impending devaluation that triggers capital outflows, which ultimately leads to currency crises. Unless some satisfactory means are found to stabilise exchange rates, moves towards market liberalisation and deregulation will continue to threaten economic stability and growth. Whether stabilising exchange rates is feasible or desirable is, therefore, an important issue to consider in the redesign of the international financial system. The following three sections elaborate on these points. The final section summarises the conclusions.



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